Tuesday, June 7, 2011

Why I Hate Gap Ups in Extreme Oversold Conditions

Hi, traders - another crazy day on Wall Street.  Last night, I wrote about the strong possibility of a bounce in this market due to oversold levels from which bounces typically occur.   I tried to clarify it by writing, "We should see a relief bounce soon but maybe only after another intraday selloff.   I would be looking to cover some shorts if we happen to get a morning selloff tomorrow."   That selloff never came - in fact, we had a gap up to open - and you saw the true strength of the "bounce" by the action in the final hour. 

Although I was watching the market, I did nothing today.  I was hoping for a gap down or at least some early morning selling from which to potentially enter some long ETFs, but that never came.   I really, really, really didn't like seeing the market open higher.   A slightly higher open in extremely oversold conditions usually is just an invite for traders to take profits while they can and they certainly did that by the end of today's session.  Every single bounce attempt today was sold hard, especially in the final hour.

The other reason I don't like slightly higher opens in oversold conditions is that they usually serve no purpose other than to relieve some of those oversold conditions ever so slightly that it allows the market to resume its selling.   You can see below that that is exactly what happened today.   We are now in a position where although we are still oversold, we may see the selling really accelerate here.   Anytime the market is oversold and the indices STILL close at their lows, you are looking at a recipe for trouble.

Besides a long position in TSM which I am riding with a stop, I am in cash and perfectly content.   I am still frustrated as positions I get stopped from continue to move without me (SODA from today is the latest example).   However, it is what it is.  I do think it is still too late to short here, but any sort of bounce we get should be looked at as an opportunity to do so, especially if the markets can get up near their short-term moving averages.

There is nothing wrong with sitting the market out for the time being, and right now that's probably the best play, at least for me.   I don't think we're ready for a playable bounce yet based on today's action, but the big gains on shorts have already taken place.   Sit tight and wait - that's all you can do.  If we get one more nasty selloff, maybe we could see a nice bounce, but that's a big "if".  Good luck Wednesday.

1 comment:

Anonymous said...


What would be your strategy as we approach Japan earthquake lows of 1,250 and the 200-day moving average ? Would you buy it long against support, or try shorting through ? Likewise I'm in cash (although I do have a small short position I've been holding in the S&P-500 since March).

Instead of playing a broad index play, I may short USO if we break support @ 1,250. It's been tough trading the broad indexes for swings.